The Impact of Capital Structure on Profitability of Commercial Banks in Ethiopia

Abstract

The choice of capital structure is one of the most important strategic financial decisions of firms. Since financing decisions influence profitability and hence firm’s value, this study examines the impact of capital structure on profitability of core business operations of commercial banks in Ethiopia. In order to meet the objectives of this study a quantitative panel data methodology was employed. The panel data were obtained from the audited financial statements of eight commercial banks and National Bank of Ethiopia for the period of twelve years (2001/02 – 2012/13). It was observed that 89% of the total capital of commercial banks in Ethiopia in the period under study was made up of debt. Of this, 75% constitute deposit and the remaining was non-deposit liabilities. This has reaffirmed the fact that banks are highly levered institutions. The findings revealed that capital structure as measured by total debt to asset had statistically significant negative impact, whereas deposit to asset had statistically significant positive impact on profitability of core business operations of commercial banks. Moreover, loan to deposit, spread and asset size also had statistically significant and positive relationship with profitability. However, growth found to have statistically insignificant impact on profitability. Therefore, banks should give due consideration to manage their debts properly, mobilize deposit sufficiently, increase loan advances, spread, and size in their financing decisions. Furthermore, banks also advised to reduce non-deposit debt financing and raise equity financing so that to keep costs of financing at minimum level and hence optimize profitability and the value of banks. Besides, the policy maker, National Bank of Ethiopia also recommended reconsidering to raise the minimum capital requirement for banks. Finally, future researchers also recommended assessing the overall performance of banks and other business sectors in the area of this research.